Sustained and Inclusive Economic Growth: Fighting Economic Inequality

By Madhavi Roy

Income inequality, wealth disparity, or the gap between the rich and the poor are synonymous terms, which refer to the unequal distribution of wealth, assets, and income between different individuals of a population. According to latest UNESCAP (United Nations – Economic and Social Commission for Asia and Pacific) reports, economic inequality in many major economies, such as India, China and Indonesia, has been steadily increasing (1). The Gini Coefficient, named after the Italian statistician and sociologist Corrado Gini, is a measure of income inequality, and ranges from 0 (all households having the same income) to 1 (or 100%, i.e., all income received by one household) (2). Greater the value of the Gini Coefficient, greater the income inequality within a nation. For India, the Gini coefficient has risen from 30.8 in the 1990’s to 33.9 in the first decade of the 21st century (3). The average income of India’s richest 10% is 8.9 times more than that of the poorest 10% (UN) (4). India’s per capita income stands at 123 in the world rankings (World Bank, 2013) (5). India has the highest number of under-5 deaths in the whole world, with 1.4 million children dying before the age of 5. One-third of the 1.2 billion ‘extremely poor people’ (those who earn less than USD 1 per day) in the world reside in India, and 17% of the global maternal deaths take place in India (6). And yet, India is the 10th richest country in the world (World Bank reports, 2013), with a GDP (nominal) of 1,876,797 million USD. (7).

In the light of this massive income inequality, Thomas Piketty (Professor, Paris School of Economics, and author of the famous book- Capital in the 21st Century) has stated that 8% – 9% of India’s national income is concentrated in the hands of the top 1%, with the gap between the top 1% and the poorest 20% of India getting wider (8). This is also evident in the rural-urban divide, with Barclays predicting that 35% of the population will reside in urban areas by 2020, while the urban population contributes 70%-75% of India’s GDP, thus broadening the inequality in income distribution between urban and rural India, and leading to greater income inequality (9).

Although the new government seems optimistic about its poverty alleviation programmes and visions, there is a lot of ground the government has to cover before we can even dream of equity in our nation.

In India, income inequality is exacerbated by the unequal treatment of women, and the so – called ‘lower castes’. For eons, women have been considered less capable and efficient, both physically and mentally, than men, which contributes to fewer employment opportunities for the fairer sex, irrespective of their skill and competence. Added to this is the rampant practice of female foeticide- and infanticide, and the patriarchal mind-set (which still exists in large swathes of the country) which dictates that women must remain within the confines of the household. All this taken together is the leading cause of inequality of opportunity, which further leads wealth disparity between men and women. Caste discrimination also forces various communities to live in abject poverty, as the possibilities and scope available to them are extremely restricted. For instance, caste tradition dictates that a particular sub-caste of Dalits are supposed to be manual scavengers, and this occupation is passed down through the generations.  In such a situation, acceptance of caste norms condemns the entire sub-caste to poverty, and lo! The poorest 20% remain poor, or become poorer, unable to use any opportunities that the government provides for their betterment.

Among the other causes of economic disparity are corruption (which, of late, has been massively documented and reported by the media), nepotism, and variations in state infrastructure and development. State infrastructure refers to railway networks, power supply, electricity, and schools and hospitals etc. Differences in state development expenditure, and the consequent variations in infrastructure, is the primary reason why Gujarat, Punjab, Haryana and Maharashtra (with recent additions of Tamil Nadu and Karnataka) are India’s ‘rich’ states, and Uttar Pradesh, Rajasthan, Orissa, Bihar, Madhya Pradesh, are the ‘poor’ ones (relatively, at least). (10) (3)

Taxes, various forms of taxes, be it wealth tax, income tax or indirect taxes, such as VAT, all lead to the redistribution of wealth from the affluent to the lowest rungs of society. And CSR, or Corporate Social Responsibility, which in India means that any company having a net worth of ?500 crore or more will mandatorily spend 2% of their net profits per fiscal year on CSR activities, which include “eradicating extreme hunger and poverty,” “promotion of education,” and “ensuring environmental sustainability.” (11) (12). But are taxes and CSR really effective in bringing down income inequality and poverty? Or is this, as some critics say, a problem-solution mismatch?

CSR essentially increases corporate taxes by 2%. Mandating that 2% of net profits be spent on societal developmental activities is equivalent to a tax raise by 2%. But the question is, would a direct raise in corporate taxes have been better for the developmental aims the government strives for?  A few critics of the new CSR law answer in the affirmative.  Aneel Karnani, Professor of Strategy at the University Of Michigan Ross School Of Business, states that, “Many activities that companies undertake are both profitable and good for society. Companies would undertake these activities regardless of the law, since they are profitable activities. Under the new law, they will be able to classify these activities as CSR with no real change in social welfare.” He further adds, “Even to the extent that there would be a real increase in socially beneficial activities, the spending would not go to democratically determined priorities, but rather to whatever the companies prefer to emphasize. It is the government’s responsibility to determine high-priority needs of society and target public expenditures in these areas. With the proposed law, the government is abdicating one of its primary functions. It would be preferable for the government to impose a tax on companies and use the additional funds to provide public goods and reduce inequality in a systematic and democratic manner.” (11)

Moreover, another fact that critics bring to light is the issue of excessive corporate taxation. In India, the corporate tax rate is 33.99%, much higher than the global average of 23.57% (KPMG) (13).  Increasing this corporate tax will only reduce India’s attractiveness as an investment destination. And this may have an adverse effect on economic growth. And one mustn’t forget that the poor also benefit from economic growth, due to increased incomes as well as employment opportunities (11). Thus, the verdict isn’t out yet about whether CSR can really achieve what the government hopes it will.

Added to the earlier analysis on corporate taxation are the views of Arthur Okun, who in his 1975 book ‘Equality and Efficiency: The Big Trade-off’ explained the trade-off between equality and efficiency. He stated that a more ‘equal’ distribution of income reduces inequalities, but also reduces incentives to work, both for those from whom the income is taken via taxes, i.e., the ‘wealthy’, and also those to whom this income is given, via subsidies or other types of social benefits, i.e., the ‘poor’ (2). Increasing taxes reduces the opportunity cost of not working, and thus people work less. On the other hand, receiving greater social benefits, such as unemployment benefits, subsidies, a higher minimum wage, etc., also reduces the motivation to work hard. And thus, Okun believed that there exists a negative relationship between equity and efficiency. His views are shared by many around the globe, even today. Prominent Republican Rick Santorum had stated this in 2012: “There is income inequality in America. There always has been and hopefully, and I do say that, there always will be. Why? Because people rise to different levels of success based on what they contribute to society and to the marketplace, and that’s as it should be. We should celebrate like we do in the small towns all across America. You celebrate success. Why? Because in their greatness and innovation, yes – they created wealth, but they created wealth for everybody else. And that’s a good thing, not something to be condemned in America.” Thomas Garrett, Assistant Vice President of the St. Louis Federal Reserve (USA) stated that income inequality is “a by-product of a functioning capitalist society” and the wealthiest had more, because they were more productive. (Holly Ellyatt, CNBC). Thus, these personalities believed (and perhaps still believe) that income inequality spurred growth and thus was not only natural, but desirable. (14)

However, a recent study by IMF economists Andrew G. Berg and Jonathan D. Ostry found that “nations with relatively low income inequality do better at achieving sustained economic growth as opposed to occasional spurts.” (Paul Krugman, The New York Times). And Mr. Krugman further clarifies, that within the euro area, countries doing a lot of redistribution have, if anything, weathered the Eurozone crisis better than those that do less. And although it is true that taxes reduce incentives for both the rich and the poor, resources also matter in an unequal society. And the poor definitely don’t have them. (15) (2)

Thus, policies to reduce inequality have both pros as well as cons. And how these policies fare will be different for each country. It is true that GDP will be affected, perhaps adversely, by large scale income redistribution schemes. And the top 1% won’t be happy. Yet, short term GDP growth has to be forsaken for a long term vision of sustained economic growth. And this will help in poverty alleviation, and economic well-being for the years to come.

References:

1. http://articles.economictimes.indiatimes.com/2014-10-03/news/54599647_1_income-inequality-gini-coefficient-poor-rich-gap
2. http://www.imf.org/external/pubs/ft/fandd/2011/09/berg.htm
3. http://blogs.lse.ac.uk/indiaatlse/2013/03/27/why-inequality-in-india-is-on-the-rise
4. http://en.wikipedia.org/wiki/List_of_countries_by_income_equality
5. http://en.wikipedia.org/wiki/List_of_countries_by_GDP_%28PPP%29_per_capita
6. http://timesofindia.indiatimes.com/india/India-is-home-to-worlds-1/3rd-of-extreme-poor-population-UN-study/articleshow/38512305.cms
7. http://en.wikipedia.org/wiki/List_of_countries_by_GDP_%28nominal%29
8. http://timesofindia.indiatimes.com/home/stoi/deep-focus/Top-1-in-India-owns-8-9-of-national-income-rockstar-economist-Thomas-Piketty-says/articleshow/34949259.cms
9. http://www.business-standard.com/article/news-cm/urban-population-to-contribute-70-75-of-india-s-gdp-by-2020-barclays-114032000273_1.html
10. http://en.wikipedia.org/wiki/Economic_inequality

Madhavi Roy is a student of Economics at the University of Delhi. Always an avid reader, she discovered her passion for writing during her tenure at The Indian Economist as a Senior Editor. Apart from Economics, she enjoys reading books and articles on varied topics like Psychology, Metaphysics, Religion, and Culture. Nothing describes her motto in life better than Ayn Rand’s famous quote, “Man exists for the achievement of his desires”. She would love to hear YOUR thoughts and views about her articles, or frankly, about anything and everything under the sun: madhu.roy14@gmail.com.